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Has it ever happened to you that you place a trade on something and immediately following that, there is a complete reversal in the market that causes a hit to your stop-loss? Don’t feel bad; you’re not alone in this experience. The majority of retail traders exist within certain patterns, and many of the Smart Money players know how to exploit this behavior.
Smart Money Concepts (SMC) is both an advanced and effective methodology of price action, which focuses on understanding the flow of orders generated by institutional traders. SMC goes beyond just looking at patterns or indicators, but rather focuses on understanding how institutions and their capital move across the various chart timeframes. This SMC guide aims to make SMC less complicated, provide definitions of some of the key components used in SMC, and provide information on how to navigate the process of trading like a professional trader.
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What is Smart Money?
Smart Money refers to the institutional players (i.e., large banks, hedge funds, and Market Makers) who utilize a sizeable amount of capital within the financial markets. The volume of trades that these institutional players generate significantly impacts price, and human traders do not have the same volume of capital to trade with as these institutional players do.
With SMC Trading, we analyse where these institutional players have entered the market and, most importantly, where they need to go to find the liquidity required to complete their exceptionally large orders.
Smart Money vs. Retail Money
The foundation of Smart Money Concepts is the notion that liquidity is often needed by institutions when making entries or exits from their positions in the market, without causing large price swings against themselves.
The foundation of Smart Money Concepts is the notion that liquidity is often needed by institutions when making entries or exits from their positions in the market, without causing large price swings against themselves.
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Foundational SMC Tools
In addition to identifying liquidity targets, Smart Money Concepts also uses unique analytical tools that assist traders in analysing price movements and understanding institutional trading activity. To be successful with an SMC trading strategy, it is important for you to learn these concepts.
1. Market Structure: BOS and CHoCH
Traders who trade using the SMC method typically begin by defining the trend.
Break Of Structure (BOS) – Indicates continuing upside momentum while price has made a higher high than the last swing point.
Change Of Character (CHoCH) – Indicates weak price action that indicates the potential of a reversal from either upward or downward momentum from the current trend.
2. Order Blocks
An Order Block (OB) is arguably one of the most important Smart Money Concepts.
Definition: An Order Block is defined as the last candle that has an opposite color (not the same as the previous candle) before the massive displacement created by a major move or break in market structure.
Institutional Logic: The Order Block is the last candle in which a large number of orders (either buy or sell) were executed by a financial institution or large investor. Because not all of the orders are filled when the price returns to that Order Block, it usually becomes a good area for the price to reverse and retest in the direction that it was trending before the initial move.
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3. Fair Value Gap (FVG)
A Fair Value Gap (FVG) (also known as a market imbalance) shows an area of extreme momentum, where a lot of orders were entered and executed too rapidly.
Definition: On a candlestick chart, an FVG occurs when the third candle does not reach and/or overlap the wick of the first candle in a three-candle sequence.
Institutional Logic: An FVG indicates a price imbalance in the market; generally speaking, the price will come back to fill in the Fair Value Gap before continuing to move in the direction of the last major price move. Consequently, an FVG is a prime location for entry points and profit target zones.
SMC vs. Traditional Trading
Most of the tools and strategies included in the traditional technical analysis are used to create structures that either rely on commonly known indicators (for example, moving averages) or visible (marked) areas of repeated support or resistance. Traditional areas of Support & Resistance are well known not only to retail traders but also by the Smart Money.
Traditional: In regard to traditional methods (Support Line), the line is created from previous price lows.
SMC Trading: In regard to Smart Money Concepts (SMC), Smart Money understands retail traders typically place their stop-losses slightly below traditional support lines. Therefore, because of this knowledge, Smart Money often creates a liquidity sweep by pushing the price slightly below the area where retail traders have placed their stop-loss orders to trigger the stop-loss orders and create the volume needed to reverse sharply.
Smart Money Concepts provides a clearer framework of institutional entry points/areas of interest using Order Blocks and Fair Value Gaps (FVGs), which also provide a way to reduce stop-loss distances and increase the overall risk/reward ratio.
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Conclusion
Smart Money Concepts provides a complete and high-precision approach to stock market trading. You will begin to shift your mindset from simply responding to price action to anticipating the actions of the largest market participants.
The key to success with SMC is:
Identifying the Smart Money footprints (Order Blocks, FVGs).
Understanding where liquidity is being targeted.
The Smart Money will teach you to wait for a Break of Structure (BOS) or a Change of Character (CHOCH) to confirm your market bias.
Initially, understanding institutional trading rules and structures can be complex; however, once you incorporate these tools into your overall stock market trading strategy, they will allow you to view the market from a supply, demand, and efficiency perspective.
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